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Monthly Archives: April 2012

On April 24, the Wall Street Journal carried an article by two highly esteemed economists, Peter Diamond from MIT, a Nobel laureate, and Emmanuel Saez of UC Berkeley, a John Bates Clark medalist. The title above the article was the title shown here, except for the “Really?” part – that’s mine. I do not easily take issue with two such learned economists, since I am not an economist at all. I did learn my economics from Nobel laureates, however, so I feel justified in speaking out.

The authors’ work has suggested to them that the revenue maximizing individual marginal tax rate – the apex on Laffer’s curve – is “in or near the range of 50%-70%.” From this they conclude that raising taxes on the rich will likely produce more revenue for the government, at least until we hit the marginal rate of 50%, and perhaps higher.

To explain why they believe this will not slow economic growth, the authors point to the fact that, in postwar U.S., higher tax rates “tend to go with” higher growth, not lower. Please! Tend to go with? Is this the best standard they can find to justify their claim? Not, “cause higher growth,” not even, “are significantly related to higher growth.” Just tend to go with?

They do present data, of course, showing higher growth in the 1950-1980 range, when tax rates were “at or above 70%,” and lower growth since that time, when tax rates “were relatively low.” There were, however, some external factors in play that could also have affected growth. With regard to the earlier time period, for example, nearly every major economy in the world except the U.S. had just been destroyed by war. Not too hard to make good money when the competition has been flattened. Some have argued, in fact, that the decline in our growth rate in the 1970-1980’s time frame was due to the fact that, after we helped the rest of the world rebuild its manufacturing capacity, its technology was well ahead of our own, allowing them to take a temporary productivity lead.

A second factor that could have impacted the drop in GDP growth could be the growing size and influence of government in the economy. In 1950, we spent one-third of our budget on Human Resources (health, education, welfare, etc.). In 2011, that category had risen to two-thirds of the budget. This is non-productive expenditure that is a drag on GDP. It should not surprise that GDP growth would slow down. Thank goodness taxes were low in the latter period.

The authors admit that their data “in no way” proves that higher tax rates encourage growth. Then why present them? Is that the best the economic community can do to explain taxes and growth? Why not step back a little and ask what economics has to say about lower personal income (through higher taxes)? Simply, that lower income pushes GDP down. Why is it useful to push some dubious relationship of higher taxes and higher GDP when even the most loyal Keynesian would find fault?

Unfortunately, it gets worse. In a nonsensical attempt to explain how the increased revenue from higher taxes works its way into higher GDP, the authors suggest that, if part of the revenue goes to repay federal debt, then “more of savings go into capital investment, enhancing growth.” Who can imagine actually beginning to repay our debt with budget deficits over $1 trillion? The best we can hope for in the next thirty years is that we stop increasing the debt.

And even if debt were repaid, the idea that more of the higher tax revenue would go into capital investment is a stretch. They try to explain it by suggesting that those from whom the higher taxes are taken would only have invested a portion of it anyway, the rest going to consumption. But if all of the revenues were used to repay debt, there would be no growth in consumption by those in the lower tax brackets, so it still looks like a downward push on GDP.

Finally, the authors suggest some of the revenues could go to public investments with a high return, like education, infrastructure, and research. They forgot to mention green energy. The fact is the government is uniquely unable to influence education in a positive way based on their prior “investment” results in the field. Everybody wants to talk about infrastructure as if bridges were falling down all around us. I have no doubt we may have deferred maintenance on our infrastructure for some time, owing to the greater percentage of the budget allocated to Human Services, but I am not feeling that collapse is imminent. In fact, I am far more worried about financial collapse.

In some way I would like to be wrong in my critique of these highly regarded economists. I am sure I have missed the subtlety in some of their arguments. But not so sure that I won’t publish the critique.

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Today’s WSJ carries an article on page 2 with the headline, Wage Divide Grows Wider. I don’t want to beat a dead horse, but it’s clear this horse ain’t dead yet. Here’s what the headline should have said: Wages Continue Growing.

WSJ reports that new Labor Department figures show wages of the top 10% of earners grew faster (7%) than wages of the bottom 90% (2.5%) between mid-2009 and the first quarter of 2012. This is exactly what one would expect in a healthy, market-based economy. The important question is whether the wages of ALL workers are growing.

In a free market, workers are paid according to their contribution to their employer. Those who are most productive are paid more than the others. Over time the relative rates of change in wages among the most productive workers and the others will ALWAYS favor the most productive workers – it is a mathematical certainty.

Consider the following example. Suppose an economy has total wages of $1,000 in year one, which is split equally among 10 workers, because each worker is just as productive as the next. In year one, each worker earns $100. Now suppose that over several years, one worker’s productivity improves such that the total wage pool grows to $1,060, and that worker is awarded one-half of the improvement in wages, so that her wages are now $130. This leaves $930 available for the other nine workers, whose productivity has remained constant. These workers will now receive their equal share of the $930, or $103.33. Over the period, the wages of the most valuable worker have increased by 30%, while those of the other workers have grown by “only” 3.3%.

What conclusions can be drawn from this little economy? Well, first, the entire economy is better off than before – it now has more money to split among the same ten workers. Second, every individual worker is better off than before, even those in the slightly less fortunate 90%.

The second point is worth elaboration. The other nine workers, despite having added nothing – zero – to the incremental growth of the economy, have still enjoyed an increase in wages. This increase is totally attributable to the single employee who worked a little harder and added more value than they did. This is definitely a “rising tide lifts all boats” economy rather than the “trickle down” economy that is described by many on the left. These workers got something for nothing! Russian oligarchs would consider this downright stupid, but this is the way a free market economy works.

And yet these workers, the top 10%, are the target of criticism and ridicule because they earn more than the rest of us. What a crazy notion of fairness. Taxing them more, as the administration would like to do, taking a greater share of their productivity, and redistributing it to those who are not contributing to productivity growth in some cockeyed notion of fairness is either lunacy or intellectual dishonesty.

Of course, my example is only mathematical. How does inflation affect this wage dynamic? If our economy is, in fact, not providing an improving living for all citizens, it is a sign we are not managing it properly, that we have distorted the free market to the extent it cannot function as it should. Fortunately, and despite some monumental economic mistakes of the past few years, it appears we are still on the right path. Wages of all workers are growing, if too slowly.

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Does anyone find it puzzling that measures of income inequality in the U.S. generally begin around 1968, the year college-educated baby boomers began to enter the workforce? Let’s put the pieces together. Piece one: income distribution is measured without regard to the age of those being measured. Piece two: the older one is, the greater their earnings are likely to be.

Income distribution is measured by income level (in quintiles). It is possible that a 60 year-old resides in the lowest income quintile and a 20 year-old in the highest. However, since income level is strongly related to age, it is likely that the highest quintile includes a greater concentration of older people, and the lowest, younger people. So far, so good.

The “twist” comes when we try to measure changes in the distribution over time. If an extra large proportion of the lowest quintile in 1968 consists of twenty-something college students, as those students age and their incomes grow, they will distort the income levels in each quintile they populate. As we view income distribution today, we are witness to a significant income “bump” moving through the quintiles since 1968, making it appear that income is being concentrated in the upper quintiles.

To see how the math works, imagine there are two age cohorts in society, ages 18-37 (Cohort A) and ages 38-57 (Cohort B). All those in each cohort earn $50,000 per year. Cohort A has 200 members, and Cohort B, 100. Income distribution in this society is concentrated in Cohort A, since it has twice the income of Cohort B, and yet each member of society earns the same $50,000 per year. In the future, the population of Cohort B will increase to 200, and that of Cohort A will shrink to 100. At this point, income will be said to be concentrated in Cohort B, while all members of society are still earning the same $50,000.

Many factors influence the conclusions we should draw from measuring income distribution. This is one that has not received much notice, but is likely to have a significant effect. Don’t stand for the unquestioning acceptance of growing income inequality by press and pundits. It is just not as simple as they want to make it.

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Luigi Zingales, professor of economics at the University of Chicago, writes that participants in a free market understandably try to gain a competitive advantage, tipping the market in their favor. As a result, he says, a free and balanced market has no natural advocate or defender. This column aims to fill a small part of that vacuum.

How often do we hear today that the free market is a lawless and heartless place and needs the government to play a greater role to assure society is treated fairly there? Anyone who makes that point knows very little about the subject. In the first place, who can name more than five markets in the U.S. that could be considered free? The crushing hand of the government is omnipresent in commerce today, whether through interference in pricing decisions, forced allocation of capital, a crazy tax structure, or regulations too numerous to count.

Second, a market has no soul. It is the participants who consistently act in their own, selfish interest rather than that of society. Shame be heaped upon them! The complainers do not know of the glorious irony of the invisible hand, that people acting in their own self-interest must satisfy the needs of others, or fail. No ambiguity there. And a place where everyone is trying to satisfy others can hardly be called heartless. Hats off to Adam Smith for his “duh!” moment.

And third, the government itself helps create market imbalances – huge imbalances – by doling out favors to those with the loudest mouths and largest bank accounts.

Indeed, the free market reels around like a punch-drunk fighter, a shell of its real self. There are only two economic paths a society can take, and they are polar opposites – toward a free market or toward a centrally managed market. Can anyone make a rational case for the latter in the 21st century? Let’s make sure we are at least headed in the right direction, the one that enables greater personal liberty and economic growth.